Earn2 CE credits

This course was written for dentists, dental hygienists,

and assistants.

Basic Financial Statement Analysis (It’s not as scary as you think!)A Peer-Reviewed Publication Written by Kathryn Franzone, MAFM

AbstractNothing can strike fear into the hearts of non-financial managers like the term “Financial Statements.” However, in order to run a successful business, it is essential to know how to read and interpret your practice’s financial statements. These documents contain valuable information about the financial position and financial health of your business. With a little background knowledge and some simple calculations, you can be on your way to a better understanding of this valuable information.

This course will show you what a balance sheet and income state-ment look like. It will help you to recognize the various accounts listed on the statements and explain how to use that information to gain an understanding of the practice’s financial performance and position.

Educational Objectives:At the conclusion of this educational activity participants will be able to:1. Identify a balance sheet and

income statement.2. Analyze information obtained

from financial statements using basic financial ratios.

3. Implement financial evaluations in the dental practice.

Author ProfileKathryn Franzone, MAFM, is a graduate of Keller Graduate School of Management. She has worked in the accounting field for ten years. Kathryn can be reached at kathryn.franzone@gmail.com .

Author DisclosureKathryn Franzone has no commercial ties with the sponsors or the providers of the unrestricted educational grant for this course.

Publication date: Aug. 2014 Expiration date: July 2017

This educational activity was developed by PennWell’s Dental Group with no commercial support.This course was written for dentists, dental hygienists and assistants, from novice to skilled. Educational Methods: This course is a self-instructional journal and web activity. Provider Disclosure: PennWell does not have a leadership position or a commercial interest in any products or services discussed or shared in this educational activity nor with the commercial supporter. No manufacturer or third party has had any input into the development of course content.Requirements for Successful Completion: To obtain 2 CE credits for this educational activity you must pay the required fee, review the material, complete the course evaluation and obtain a score of at least 70%.CE Planner Disclosure: Heather Hodges, CE Coordinator does not have a leadership or commercial interest with products or services discussed in this educational activity. Heather can be reached at hhodges@pennwell.comEducational Disclaimer: Completing a single continuing education course does not provide enough information to result in the participant being an expert in the field related to the course topic. It is a combination of many educational courses and clinical experience that allows the participant to develop skills and expertise.Image Authenticity Statement: The images in this educational activity have not been altered.Scientific Integrity Statement: Information shared in this CE course is developed from clinical research and represents the most current information available from evidence based dentistry. Known Benefits and Limitations of the Data: The information presented in this educational activity is derived from the data and information contained in reference section. The research data is extensive and provides direct benefit to the patient and improvements in oral health. Registration: The cost of this CE course is $49.00 for 2 CE credits. Cancellation/Refund Policy: Any participant who is not 100% satisfied with this course can request a full refund by contacting PennWell in writing.

Supplement to PennWell Publications

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PennWell designates this activity for 2 Continuing Educational Credits

Dental Board of California: Provider 4527, course registration number CA# 02-4527-14076“This course meets the Dental Board of California’s requirements for 2 units of continuing education.”

The PennWell Corporation is designated as an Approved PACE Program Provider by the Academy of General Dentistry. The formal continuing dental education programs of this program provider are accepted by the AGD for Fellowship, Mastership and membership maintenance credit. Approval does not imply acceptance by a state or provincial board of dentistry or AGD endorsement. The current term of approval extends from (11/1/2011) to (10/31/2015) Provider ID# 320452.

This course is approved for AGD credits only it is not approved for ADA credits

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Educational Objectives:At the conclusion of this educational activity participants will be able to:1. Identify a balance sheet and income statement.2. Analyze information obtained from financial statements using

basic financial ratios.3. Implement financial evaluations in the dental practice.

AbstractNothing can strike fear into the hearts of non-financial managers like the term “Financial Statements.” However, in order to run a successful business, it is essential to know how to read and interpret your practice’s financial statements. These documents contain valu-able information about the financial position and financial health of your business. With a little background knowledge and some simple calculations, you can be on your way to a better understanding of this valuable information.

This course will show you what a balance sheet and income state-ment look like. It will help you to recognize the various accounts listed on the statements and explain how to use that information to gain an understanding of the practice’s financial performance and position.

What exactly is accounting?While knowing all of the details of accounting isn’t necessary to gain an understanding of financial statements, there are a few things you should know. In its most basic form, accounting is the recording of business transactions and their dollar amounts. In the United States, all accounting is done according to Generally Accepted Accounting Principles, or GAAP. It is these principles that dictate when, where and how each transaction should be recorded and subsequently reported on the financial statements. There are three basic financial statements: the balance sheet, the income statement and the state-ment of cash flows. This course will focus on the balance sheet and income statement.

What is a Balance Sheet?The Balance Sheet, also called a statement of financial position, is a summary of an organization’s assets, liabilities and equity as of a specific date. It is based on the fundamental accounting equation Assets = Liabilities + Owners’ Equity. This equation must always be in balance. For example, if you take out a loan to buy new equip-ment, your assets will go up and your liabilities will go up as well. Similarly, if you use cash to buy new equipment, their correspond-ing accounts will increase and decrease accordingly, keeping the equation in balance.

Assets are things that an organization owns. They are listed on the balance sheet according to their liquidity, or how quickly they can be converted into cash. Liabilities are amounts that an organiza-tion owes to someone else, such as vendors and banks. They are list-ed according to when they are due, with the most current liabilities first. Stockholders’ equity, also called owners’ equity, is the amount that would remain if all liabilities were paid using the organization’s assets. One important thing to know about stockholders’ equity is that it does not necessarily represent the value of the company.

What is an Income Statement?The Income Statement, also called a Profit & Loss statement (P&L), provides information about how the company performed financially over a specific period of time. It can be used to determine profitability, how credit-worthy the company is and to make predic-tions about future financial performance based on past information.

GAAP mandates that public companies use accrual-based accounting and complete their financial statements accordingly. In accrual-based accounting revenues are recorded when they are earned, not necessarily when they are received. Similarly, expenses are recorded when they are incurred, not when they are paid. How-ever, many small, private businesses including dental practices, keep their records on a cash basis and record revenues when they are received and expenses when they are paid, not necessarily when they

Figure 1. Balance sheet

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are earned and incurred. While this doesn’t change the look of the income statement, it is something you want to keep in mind when analyzing the statements.

One thing that will change the look of the income statement is the nature of the business. The income statement for a manufac-turing company will look slightly different from that of a service company. Accounts such as “cost of goods sold” are not applicable to service industries and are therefore not on the income statement. The income statement below is an example of an income statement for a company in the service industry.

Figure 2. Income statement

The Basics of Financial AnalysisNow that you understand a bit more about what the numbers represent and where they come from, you may be wondering what they all mean. Financial ratios are one technique that you can use to analyze the data found on the balance sheet and income statement. Financial ratios are classified into four categories: liquidity ratios, activity ratios, profitability ratios and long-term debt-paying abil-ity (or coverage) ratios.

Liquidity RatiosLiquidity ratios measure an organization’s ability to pay their short-term debts. Debt is considered short-term when it is due within the next twelve months.

The current ratio (also called the working capital ratio) can be a good indicator of a company’s ability to repay its current liabilities using its current assets. The higher the current ratio, the more likely a company would be able to pay their current debts. If the current ratio is less than 1, this could cause concern that the company would not be able to pay off their current debts if they came due at that time.

Current ratio = Current assets/Current liabilities

Using our balance sheet example, the calculations for Mo-Lar Dental would be:

2013 Current ratio = 50,000/34,000 = 1.47 2012 Current ratio = 35,000/25,000 = 1.4

Mo-Lar Dental’s current ratio improved between 2012 and 2013, indicating that their ability to pay short term debt has improved as well. A current ratio of 1.47 means that for every $1.00 of current li-abilities Mo-Lar has, it has $1.47 of assets to cover it (or pay it). If the dental practice industry average was 1.15 and Mo-Lar had a current ratio of 1.47, this would indicate that Mo-Lar was in a better position to pay its current obligations than the average dental practice.

The acid-test ratio, sometimes called the quick ratio, is similar to the current ratio. The acid-test ratio, however, excludes inventory and prepaid accounts in its figure for current assets. This is because these items are the least liquid of the current assets. In other words, they are the most difficult to turn into cash. The acid-test ratio only uses the company’s most liquid assets to determine how well they would be able to meet their short-term obligations.

Acid-test ratio = (Cash equivalents + Marketable securities + Net receivables)/Current liabilities

In our example, Mo-Lar Dental has no marketable securities, so the calculations would look like this:

2013 Acid-test ratio = (14,000 + 30,000)/34,000 = 1.292012 Acid-test ratio = (12,000 + 18,000)/25,000 = 1.2

The acid-test ratio for Mo-Lar Dental has improved slightly from 2012 to 2013, indicating that for every $1.00 in current liabili-ties Mo-Lar has, they have an additional $.09 to cover it (1.29 vs. 1.20). Another way to look at the acid-test and current ratios is to compare them to each other. If a company’s acid-test ratio is signifi-cantly lower than its current ratio then that indicates that its current assets contain large amounts of inventory and prepaid accounts.

Activity Ratios Activity ratios are used to measure how efficiently an organization uses its assets. They indicate how well management is able to turn assets such as inventory and accounts receivable into cash.

The accounts receivable turnover ratio indicates management’s ability to collect their outstanding accounts receivable.

Accounts receivable turnover = Net credit sales/Average net receivables

Mo-Lar Dental does not list credit sales separately from cash sales on its balance sheet. For our calculations, we will assume that Mo-Lar had $100,000 in sales for 2013 and that 50% of sales are made on credit.

Accounts receivable turnover = 50,000/ [(30,000 +18,000)/2] = 2.08 times

With an accounts receivable turnover ratio of 2.08, that means that Mo-Lar Dental collected its accounts receivable roughly two times during the year. We can then take that ratio and divide it into 365 to

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determine the average number of days it takes Mo-Lar to collect its accounts receivable. This is the accounts receivable turnover in days.

Accounts receivable turnover in days = 365/Receivable turnover = 365/2.08 = 175 days

Therefore it takes Mo-Lar Dental, on average, 175 days (or six months) to collect its sales made on credit. It is management’s responsibility to determine what an acceptable accounts receiv-able turnover ratio is for their organization, however, in general, the higher the ratio is, the better position the organization is in.

Profitability RatiosProfitability ratios use information from both the income state-ment and the balance sheet to measure whether or not the orga-nization’s efforts to be profitable during a period of time were successful.

Return on total assets measures how well an organization is using its assets in relation to the amount of income it has re-ported.

Return on total assets = Net Income/Average total assets

Using the information from Great Brushers income state-ment and assuming they reported an average of $2,000,000 in as-sets on their balance sheets, the calculation would look like this:

2012 Return on total assets = 213,710.83/2,000,000 = 10.7% 2013 Return on total assets = 307,840.15/2,000,000 = 13.2%

This means that Great Brushers management is effectively managing their assets in order to produce a profit (return).

Long-Term Debt-Paying Ability RatiosLong-term debt-paying ability ratios determine just that – an or-ganization’s ability to cover their long-term obligations. They are also called solvency ratios, and are the long-term counterparts to liquidity ratios, which measure short-term debt-paying ability.

The debt ratio compares the amount of assets an organization has to the amount of liabilities.

Debt ratio = Total liabilities/Total assets

For Mo-Lar Dental the debt ratio would be:

Debt ratio = 234,000/395,000 = 59.24%

Therefore, 59.24% of the company’s assets are financed by liabilities. The higher this ratio, the higher the organization’s de-gree of leverage and the lower the organization’s solvency, which can lead to financial risk.

How to Use the RatiosFinancial ratios can tell you a lot about your business, but simply calculating them isn’t enough. These ratios need to be compared, whether it is intra-company from one period to the next or against industry averages. Industry averages vary greatly between in-dustries, as well as from year to year, so you should consult your accountant to obtain the most current industry averages.

The best way to use financial ratios is to calculate them on a regular and ongoing basis. For example, you may want to start by calculating them quarterly. If you get a result that is worrisome, you could increase the frequency to monthly. The results from each quarter can be compared to previous quarters in the same year to track the progress of the company for that year. They can also be compared to the same time period in previous years, to track changes year to year.

Which financial ratios you should calculate depends highly on your practice and exactly what you want to know. For ex-ample, if your practice extends credit to many of its patients, you may want to pay special attention to the accounts receivable turnover ratio. Similarly, if your company has long-term loans on its books that will be coming due soon, you may want to keep an eye on the various liquidity ratios to determine whether or not you will have enough cash to cover the payments.

An Ongoing Learning ProcessOne course can’t teach you everything there is to know about financial statements and how to analyze them. Reading and interpreting the information that is found on the income state-ment and balance sheet is an ongoing process and can take a long time to master. However, armed with some basic knowledge of the statements and some simple financial ratios that can be cal-culated using them, you’re on your way to a better understanding of the financial side of your business.

Author profileKathryn Franzone, MAFM, is a graduate of Keller Graduate School of Management. She has worked in the accounting field for ten years. Kathryn can be reached at kathryn.franzone@gmail.com.

Author DisclosureKathryn Franzone has no commercial ties with the sponsors or the providers of the unrestricted educational grant for this course.

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Questions

Online CompletionUse this page to review the questions and answers. Return to www.ineedce.com and sign in. If you have not previously purchased the program select it from the “Online Courses” listing and complete the online purchase. Once purchased the exam will be added to your Archives page where a Take Exam link will be provided. Click on the “Take Exam” link, complete all the program questions and submit your answers. An immediate grade report will be provided and upon receiving a passing grade your “Verification Form” will be provided immediately for viewing and/or printing. Verification Forms can be viewed and/or printed anytime in the future by returning to the site, sign in and return to your Archives Page.

1. Accounting in the United States is performed according to:a. Federal Accounting Standardsb. Generally Accepted Accounting Principlesc. The IRSd. Mandatory Financial Rules

2. What fundamental accounting equation is the balance sheet based on?a. Assets = Liabilities + Stockholders’ Equityb. Assets + Liabilities = Stockholders’ Equityc. Gains – Losses = Revenuesd. Revenues - Expenses = Income

3. Another name for the Income Statement is:a. Cash Receipt Statementb. Financial Leverage Statementc. Chart of Accountsd. Profit & Loss Statement

4. A balance sheet:a. presents financial information as of a specific moment

in timeb. presents financial information over a period

of timec. balances gains and lossesd. none of the above

5. Liquidity ratios measure:a. a company’s ability to pay long-term debtsb. the amount of a company’s short-term debts versus

their long-term debtsc. a company’s ability to pay short-term debtsd. the market value of a company

6. If a Drills-R-Us has $20,000 in current assets and $10,000 in current liabilities, what is their current ratio?a. 1.2b. 0.5c. 2.0d. .76

7. Activity ratios help to determine:a. how efficiently a company uses its assetsb. the level of business activity during a period of time.c. when the busiest time of year is for a companyd. whether or not the company made a profit

8. If a company has average net receivables of $15,000 and net credit sales of $63,000, what is their accounts receivable turnover in days? a. 4.2b. 93.44c. 2.1d. 86.90 (63,000/15000 = 4.2; 365/4.2 = 86.90)

9. If a company’s debt ratio is high, this indicates:a. they do not use financing to purchase assetsb. that they have recently paid off all of their debtc. that a high percentage of their assets are financed by

creditorsd. that they are in bankruptcy

10. Financial ratio analysis:a. tells us everything we need to know about a company’s

financial positionb. is a useful tool to help gain understanding of a

company’s financial positionc. is very difficult and must be done by a professionald. none of the above

11. Which of the following is not a type of financial ratio:a. Liquidityb. Profitabilityc. Compatibilityd. Activity

12. A balance sheet presents financial information:a. As of a specific point in timeb. Spanning a period of timec. For three years at a timed. One year at a time

13. The income statement presents financial information:a. As of a specific point in timeb. For the last day of the yearc. For a specific period of timed. None of the above

14. What should be done once the financial ratios have been calculated?a. Nothing, you’re finishedb. They should be added together and averagedc. They should be complied in a listd. They should be compared to previous periods’ results,

industry averages and/or similar businesses’ ratios

15. How are assets listed on the balance sheet?a. According to their liquidityb. According to their valuec. According to their aged. In alphabetical order

16. What is stockholders’ (or owners’) equity?a. The value of the companyb. The amount that would remain after all liabilities were

paid using assetsc. The total value of the company’s assetsd. The degree of power management has in decision

making

17. What is the formula for the debt ratio?a. Debt Ratio = Total Liabilities/Total Assetsb. Debt Ratio = Total Assets – Total Liabilitiesc. Debt Ratio = Net Income – Current Liabilitiesd. Debt Ratio = Current Liabilities/Net Income

18. The bottom line of the income statement tells us:a. Sales for the current periodb. Expenses for the current periodc. Total debt for the current periodd. The company’s profit or loss for the period

19. A current ratio less than one could indicate:a. The company is in an excellent financial positionb. The company may have difficulty paying off its

current liabilitiesc. The company will not be able to pay off their long-

term obligationsd. The company has an abnormally high amount of

assets

20. Why does the acid test ratio exclude inven-tory and prepaid accounts from the assets portion of the equation?a. Because they are not assetsb. Because they are the least liquid of the current

assetsc. Because their values change too oftend. None of the above

Customer Service 216.398.7822

Educational Objectives1. Identify a balance sheet and income statement.

2. Analyze information obtained from financial statements using basic financial ratios.

3. Implement financial evaluations in the dental practice.

Course Evaluation1. Were the individual course objectives met? Objective #1: Yes No Objective #2: Yes No

Please evaluate this course by responding to the following statements, using a scale of Excellent = 5 to Poor = 0.

2. To what extent were the course objectives accomplished overall? 5 4 3 2 1 0

3. Please rate your personal mastery of the course objectives. 5 4 3 2 1 0

4. How would you rate the objectives and educational methods? 5 4 3 2 1 0

5. How do you rate the author’s grasp of the topic? 5 4 3 2 1 0

6. Please rate the instructor’s effectiveness. 5 4 3 2 1 0

7. Was the overall administration of the course effective? 5 4 3 2 1 0

8. Please rate the usefulness and clinical applicability of this course. 5 4 3 2 1 0

9. Please rate the usefulness of the supplemental webliography. 5 4 3 2 1 0

10. Do you feel that the references were adequate? Yes No

11. Would you participate in a similar program on a different topic? Yes No

12. If any of the continuing education questions were unclear or ambiguous, please list them. ___________________________________________________________________

13. Was there any subject matter you found confusing? Please describe. ___________________________________________________________________ ___________________________________________________________________

14. How long did it take you to complete this course? ___________________________________________________________________ ___________________________________________________________________

15. What additional continuing dental education topics would you like to see? ___________________________________________________________________ ___________________________________________________________________

ANSWER SHEET

Basic Financial Statement Analysis (It’s not as scary as you think!)

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Address: E-mail:

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Requirements for successful completion of the course and to obtain dental continuing education credits: 1) Read the entire course. 2) Complete all information above. 3) Complete answer sheets in either pen or pencil. 4) Mark only one answer for each question. 5) A score of 70% on this test will earn you 2 CE credits. 6) Complete the Course Evaluation below. 7) Make check payable to PennWell Corp. For Questions Call 216.398.7822

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Answer sheets can be faxed with credit card payment to (440) 845-3447, (216) 398-7922, or (216) 255-6619.

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Customer Service 216.398.7822 www.ineedce.com

PLEASE PHOTOCOPY ANSWER SHEET FOR ADDITIONAL PARTICIPANTS.COURSE EVALUATION and PARTICIPANT FEEDBACK

We encourage participant feedback pertaining to all courses. Please be sure to complete the survey included with the course. Please e-mail all questions to: hhodges@pennwell.com.

INSTRUCTIONSAll questions should have only one answer. Grading of this examination is done manually. Participants will receive confirmation of passing by receipt of a verification form. Verification of Participation forms will be mailed within two weeks after taking an examination.

COURSE CREDITS/COSTAll participants scoring at least 70% on the examination will receive a verification form verifying 2 CE credits. The formal continuing education program of this sponsor is accepted by the AGD for Fellowship/Mastership credit. Please contact PennWell for current term of acceptance. Participants are urged to contact their state dental boards for continuing education requirements. PennWell is a California Provider. The California Provider number is 4527. The cost for courses ranges from $20.00 to $110.00.

PROVIDER INFORMATIONPennWell is an ADA CERP Recognized Provider. ADA CERP is a service of the American Dental Association to assist dental professionals in identifying quality providers of continuing dental education. ADA CERP does not approve or endorse individual courses or instructors, nor does it imply acceptance of credit hours by boards of dentistry.

Concerns or complaints about a CE Provider may be directed to the provider or to ADA CERP at www.ada.org/cotocerp/.

The PennWell Corporation is designated as an Approved PACE Program Provider by the Academy of General Dentistry. The formal continuing dental education programs of this program provider are accepted by the AGD for Fellowship, Mastership and membership maintenance credit. Approval does not imply acceptance by a state or provincial board of dentistry or AGD endorsement. The current term of approval extends from (11/1/2011) to (10/31/2015) Provider ID# 320452.

RECORD KEEPINGPennWell maintains records of your successful completion of any exam for a minimum of six years. Please contact our offices for a copy of your continuing education credits report. This report, which will list all credits earned to date, will be generated and mailed to you within five business days of receipt.

Completing a single continuing education course does not provide enough information to give the participant the feeling that s/he is an expert in the field related to the course topic. It is a combination of many educational courses and clinical experience that allows the participant to develop skills and expertise.

CANCELLATION/REFUND POLICYAny participant who is not 100% satisfied with this course can request a full refund by contacting PennWell in writing.

IMAGE AUTHENTICITYThe images provided and included in this course have not been altered.

© 2014 by the Academy of Dental Therapeutics and Stomatology, a division of PennWell BFINAN0814DE

AGD Code 552